Record central bank intervention buys Indian bonds, limited relief until 2026

Indian government bonds enter 2026 with a question mark over how much appetite there is for a rise in debt supply, even after a year in which the central bank hit the balance sheet with record asset purchases and 125 basis point rate cuts. The Reserve Bank of India’s (RBI) moves have helped cap yields, but bonds are still seeing a disappointing end to a year that saw the sharpest rate cuts since 2019, as supply-side concerns weaken their impact.

The benchmark 10-year yield stood at 6.59% on Wednesday, down 17 basis points through 2025, marking a third straight annual decline.

A change in the central bank’s policy stance to ‘neutral’, weaker demand from institutional investors amid heavy bond selling by the federal and state governments and a sustained decline in the rupee kept selling pressure high going into 2025.

“After the first half, the supply-demand dynamics remained in focus,” said Vijay Sharma, senior executive vice-president at PNB Gilts.

“Now that the rate cuts are behind us, we will also face supply pressure challenges this year.”

BONDS LOOK BEYOND THE DOVISH POLICY PATH

The bond markets reversed course midway through the year. Ten-year yields fell 45 basis points in the first six months as the RBI added liquidity and started cutting rates, before giving up 28 basis points of that in the second half of the year.

The central bank has pumped 11.7 trillion rupees ($130.17 billion) into the banking system through 7 trillion rupees in debt purchases, 2.2 trillion rupees in currency swaps and a 2.50 trillion rupees cut in banks’ cash reserve ratio.

This size of infusion is the largest ever in any year.

“Open market buying announcements supported the bond market, but continued pressure on the rupee kept short-term rates volatile,” said Akhil Mittal, Senior Fund Manager – Fixed Income, Tata Asset Management.

The Indian rupee is set to fall 5% in 2025, which will mark its worst decline in three years, amid record stock outflows and the absence of an India-US trade deal.

While the central bank’s aggressive support to bond markets helped, it did not fully offset weak demand in large investor segments, such as insurance companies that received smaller cash flows and pension funds, which shifted their investments to stock markets after regulatory changes.

Banks that were key participants in offering their bond positions in the RBI’s open market operations also did not fully replenish their positions, widening the supply-demand gap.

RANGE BOUND UNTIL 2026

While the initial move in bond yields will be determined by the amount of borrowing from states, major shifts are likely to depend on India’s federal budget and the central bank’s monetary policy decision, both of which will occur in February.

“The RBI is likely to remain on a long pause in 2026 as inflation remains benign. Interest rate markets are likely to remain within a range in the near term ahead of the Union Budget,” said Avnish Jain, Chief Investment Officer – Fixed Income at Canara Robeco Asset Management.

Traders will also continue to focus on the RBI’s liquidity and currency management, which will set the tone for the year.

“Going into the next year with the possibility of a trade deal, the return of FPIs and continued liquidity support from the RBI, 10-year bond yields will run around 6.30% with a range of 6.10% to 6.60%.” said Alok Singh, Head of Finance at CSB Bank.

($1 = 89.8820 Indian rupees.)